ITAT HYDERABAD BENCH ‘A’
Zavata India (P.) Ltd.
versus
Income-tax Officer, Ward 3(2), Hyderabad
IT Appeal No. 628 (Hyd.) of 2008
[ASSESSMENT YEAR 2004-05]
JANUARY 31, 2013
ORDER
B. Ramakotaiah, Accountant Member
This is an appeal by the assessee against the orders of the CIT(A)-I, Visakhapatnam dated 24.01.2008.
2. The issue in this appeal is whether the Assessing Officer is correct in invoking the provisions of S.10A(7) read with S.80IA(10) of the Act on the basis of the Transfer Pricing Study undertaken by the assessee.
3. Briefly stated, the assessee is in the business of rendering back office processing services in the field of health-care administration. Its services are not akin to call centre services, wherein tele-communication expenses constitute more than 24%. The assessee’s service centre is registered under the Software Technology Parks of India and provides services exclusively to Samsung Data Corporation USA (SDC US), its Associate Enterprise (AE). The SDC US markets services in USA. The revenue sharing policy was determined at the ratio of 85:15 on the gross receipts received from third parties.
4. For the financial year 2003-04, i.e. AY 2004-05, the assessee filed return of income and claimed deduction under S.10A to the extent of Rs. 3,15,69,530. The Assessing Officer selected the return for scrutiny and having noticed that the assessee has transactions with AE made a reference to the Additional Commissioner of Income-tax, Transfer Pricing under S.92CA(1) of the Act, for determination of Arm’s Length Price(ALP) of the International transactions relating to BPO services.
5. The assessee made TP study and based on the functional analysis chose the Comparable Uncontrolled Price (CUP) method as the most appropriate method for determination of ALP. It justified its allocation of profits on the basis of the price paid by third party for services at US$10, wherein proper BPO services/call centre services are placed, and since the assessee is not having that much telecommunication services, was paid at US$8.50, and justified the price by the CUP method.
6. Without prejudice to the primary analysis undertaken under the CUP method, the assessee also supplemented International transactions being at Arms Length Price under Transactional Net Margin Method (TNMM) and selected some comparables and arrived at the Arithmetic mean at 8%. Since the assessee’s profit margin was at 159.5% on the operating cost, it justified the Arms Length Price under the TNMM method.
7. Pursuant to detailed scrutiny of the TP documentation and the additional information provided, the TPO vide order dated 17.11.2006 concluded that the pricing of the assessee is within the Arm’s Length Standard and no adjustment is required to be made to the value of the international transactions between the assessee and its AE. However, the Assessing Officer invoked the provisions of S.10A(7) read with S.80IA(10) to consider that the assessee has earned more than the ordinary profit and considering the same TP study submitted by the assessee under TNMM method, determined the excess profit at Rs.2,99,34,750 and denied deduction under S.10A while completing the assessment.
8. The other adjustment with reference to reducing internet charges from the export turnover was deleted by the CIT(A) and therefore, that aspect of the action of the Assessing Officer was not subject matter of this appeal.
9. Assessee contended before the CIT(A) that the order of the Assessing Officer in invoking the provisions of S.10A(7) relying on the TNMM study submitted for the Transfer Pricing purposes is not correct. It raised various contentions. However, the CIT(A) confirmed the order of the Assessing Officer by stating as under-
“4.3 The next issue is whether the Assessing Officer was justified in invoking the provision of section 10A(7) r.w.s. 80IA(10) of the Act. The requirements for invoking the said sections are that (a) the must be close connection between the appellant and the other person and (b) the course of business between them should be so arranged that it produces the appellant more than the ordinary profit from such business. In the instant case, the fact of the close connection between the appellant and the other person, i.e. the AE is not disputed at all. The dispute is relating to the applicability of the conditions as specified in (b) as above. The appellant’s argument is that the provisions of section 80-IA(10) are applicable only when both the closely connected persons are taxable in India. However, perusal of the said section indicates that no such stipulation has been made in the said section. Therefore, this argument of the appellant is not tenable. The provisions of section 10A(7) r.w.s. 80IA(10) are primarily meant to check the tendency of the assessees to show higher profits of the undertakings which are eligible for tax concession. Such provisions are found in most of the other sections in the Act for granting incentives in respect of profits of certain business activities. The other argument of the appellant is that the word ‘arranged’ suggest a motive to avoid tax by manipulating the profits of the company. In this context, it was argued that the appellant had no motive as where the profits are higher the appellant has to pay more taxes in the form of dividend distribution tax owing to the income in the amount of dividend available for distribution. The argument of the appellant is not acceptable in view of the transaction analysis contained in Chapter 4 of the Transfer Pricing Report. As per the said functional analysis, the entire Corporate Strategy and Management of the group, salary and marketing activities including customer identification, presentation of technical qualification, contract negotiations and fee collection, client satisfaction/relationship, responsibility of business development, marketing and advertisement strategy, concluding contracts, supervising the projects, delivery of the projects, quality control and performance review were all the responsibilities of the AE. Further, it is noted that all market risks with respect to services including business development and customer acceptance are borne by the AE. The other risks like the service liability risk, credit and collection risk, foreign exchange risk, idle capacity risk, contractual risks, etc. was also on the AE. The appellant company had absolutely no responsibility in this regard. Further, it is noted that the value of the assets employed by the appellant company was not substantial. Therefore, it can be fairly concluded that as per the analysis of transaction the risks and responsibility of the appellant company in comparison to the AE was minimal and substantially lower. As against this, the revenue sharing ratio was heavily loaded in favour of the appellant company its sharing being 85%. Thus, this was clearly an arrangement vide which the Indian company was given a more of revenue in view of the fact that its income was totally exempted from tax u/s. 10A. This implies that the said income was ploughed back to the Directors and Share holders in the form of dividends. One of the Directors of the appellant company was Mr. Sriram Davaloor who held 50% of the share holding and being a resident of USA his income was not taxable in India. This was possibly the motive for giving bigger share of revenue to the appellant company which resulted in unjust enrichment of the foreign Director of the appellant company. Hence, this was clearly an arrangement within the meaning of such word employed in section 80IA(10). In view of the above, the AO is perfectly justified in invoking the provisions of section 10A(7) r.w.s. 80IA (10) in the case of the appellant company.
4.4 As per the primary transfer pricing analysis documented by the appellant under the CUP method, the price for the services rendered by the appellant was determined at US $ 50 per man hour which was the same as the price charged by the appellant to its AE. However, as per the additional supplementary analysis under TNMM, it is noted that the arithmetical mean of operating profit margin of comparable cases was 3.77% whereas it was 8.96% even in the cases figuring in the upper range. TNMM requires establishing comparability at a broad functional level. It requires comparison between the net margins derived from the operation of the uncontrolled parties and the net margins derived by an associate enterprise on similar operation. Under this method, the net profit margin realisation by an associate enterprise from an international transaction is computed in relating to a particular factor such as costs incurred, sales, assets., utilized etc. The net profit margin realized by an associate enterprise compared with net profit margin of uncontrolled transactions to arrive at the ALP. By making the said analysis, the appellant himself under the TNMM method indicated that the percentage of operating profit with reference to the operating cost in the case of the appellant company was 159.51%. As against this, for uncontrolled parties such margin of profit ranged between (-)1.42% to 8.96%, the arithmetical mean being 3.77%. This clearly establishes the fact that the profit of the appellant company by virtue of providing the services to the AE was very high. Therefore, the Assessing Officer is justified in fixing the ordinary profit at 8.5% keeping in view the fact that the ALP can vary upto 5% form arithmetical mean as per the proviso to sub-section 2 to section 92C. The application of the most appropriate method is essential to arrive at the most reliable measure of the ALP. Rule 10(c)(i1) of the Income-tax Rules defines the most appropriate method, which is best suited to the facts and circumstances of each particular international transaction and which provides the most reliable measure of an ALP in relation to an international transaction. Rule 10(c)(2), inter alia provides that the most appropriate method shall be selected having regard to the class or classes of Associate Enterprises entering into the transaction and the functions performed, assets employed and the risks assumed by them. In the instant case, as explained in earlier para, the entire risk of running the business by the appellant company is on the AE and the assets employed appellant company was negligible. Hence, the Assessing Officer is justified in treating the TN MM method as the most appropriate method for computation of the AKLOP. Accordingly, the Assessing Officer is justified in not considering the 151% profit i.e. 159,51% – 8.5% amounting to Rs.2,99,34,750/- as the profit of the eligible undertaking for the purposes of computation of deduction u/s. 10A of the Act. The said action of the Assessing Officer is hereby ‘confirmed’ and the grounds raised vide (i), (ii), (iii) and (iv) which are interrelated and pert5ains to the same issue, i.e. invoking the provisions of section 10(7) r.w.s. 80IA(10) are hereby ‘dismissed’.”
The assessee is aggrieved on the above.
10. The learned counsel referring to the TP study, order of the TPO and the order of the CIT(A) and the paper-book placed in this regard, submitted that the Assessing Officer was not correct in invoking the provisions of S.10A(7) read with S.80IA(10). He submitted that on a reading of Section 10A(7), CBDT Circular No 308 dated June 29, 1981 (wherein the reasons for applying Section 80IA(8) and (10) to an undertaking have been explained) and judicial precedents on the subject, the legislative intention for introduction of 80-IA(I)(10) was to apply provisions in following two situations, both of which do not apply to the facts of the case.
(a) Where both the closely connected persons are taxable in India:
The intention with reference to this situation is to cover two distinct taxable entities belonging to the same business group, in a situation, where the group may abuse such tax incentives by transferring profits of non-eligible assessees (which would be subject to tax in India) to eligible assessees (which would not be taxable). Such an abuse would result in reduction of the overall amount of tax liability in India, and consequently loss of legitimate revenue to the Indian Government exchequer. In the instant case, it is submitted, the AE is not taxable in India. The Assessing officer’s contentions that the assessee could abuse the deduction claimed by routing back of funds to the AE is not correct, since the AE is not subject to tax in India. On the contrary, it is submitted, where the profits are higher and the Appellant routes back the funds, the Appellant has to pay more taxes in the form of dividend distribution tax owing to the increase in the amount of dividends available for distribution. It is, thus, there cannot be situation resulting in loss of revenue in subsequent years. It is further submitted in this context, that the assessee has never routed any funds by way of dividends or otherwise to the AE any time from the date of incorporation to date. All the profits of the assessee have been invested in the business of the Company in India. In the circumstances, it is submitted that there is no case to invoke the provisions of Section 10A(7) read with Section 80-IA(10).
(b) Business transaction are so arranged to produce more than ordinary profits:
Dealing with the applicability of this situation to the facts of the present case, it is explained that the word “arranged” has been interpreted to suggest a motive to avoid tax by manipulating the profits of the Company. Without appreciating the facts of the assessee’s case and performing an objective analysis, it is submitted, the learned assessing officer has concluded that the Appellant has arranged its business with a view to earn more than ordinary profits. In this regard, reliance is placed on the following rulings in the context of section 80IA(10), wherein it was held that avoidance of tax must be the main motive for provisions to apply and a mere incidental benefit is not sufficient.
• The Hon’ble Supreme Court in the case of V. N. M. Arunachala Nadar v. Commissioner of Excess Profits-tax [1962] 44 ITR 352
• The Bombay ITAT in context of 80IA(10) in the case of ITO v. P.C.A. Engineers Ltd. [1984] 8 ITD 518
In this context, it is submitted that the issue under appeal is no more RES INTEGRA and has been decided by the following benches of the Tribunals which are squarely applicable to facts of the present case of the assessee:
• Visual Graphics Computing Services (India) (P.) Ltd. v. Asstt. CIT [2012] 52 SOT 172
• Tweezerman (India) (P.) Ltd. v. Addl. CIT [2010] 133 TTJ 308 (Chennai) ;
• CIT v. Schmetz India (P.) Ltd. [2012] 211 Taxman 59 ;
• Weston Knowledge Systems & Solutions (India) (P.) Ltd. v. ITO [2012] 52 SOT 120;
• Digital Equipment India Ltd. v. Dy. CIT [2006] 103 TTJ 329 (Bang.);
11. Further, the learned counsel also submitted that reliance on the same TP study of the assessee by the Assessing Officer is not correct, as the main TP study was under CUP method on the price was paid in relation to a third party, which is within Arm’s Length Standard. It was further submitted that US revenue authorities have not questioned the transfer pricing policy of the SDC US for US Transfer Pricing purposes. It was further submitted that the Assessing Officer also wrongly concluded excess profit on the basis of arithmetic mean when comparables selected by the assessee has a margin varying from – 94.26 % to + 48.32 %. It was further submitted that the assessee has operational advantages as it has less cost on telecommunications and other operational advantage in staff salaries etc. whereas the comparable cases selected are not exactly in BPO business like assessee and they also have software development and other activities. Since the Transfer Pricing Officer accepted that the assessee’s transactions are at Arms Length, the Assessing Officer was not correct in invoking the provisions of S.10A(7). It was further submitted that it has received a market price for its services and the reasons for good margin is the pricing policy, location, savings and low cost of work force. Since the operating cost is less, the percentage of profit looks more, but the assessee has received the standard price for its services rendered to the AE. Since the receipts of assessee were fixed, profits increased because of reduction in the operating costs. Therefore, operational efficiency cannot be taken to be detrimental to the assessee’s interests as far as earning of profit is concerned. It was further submitted that there was no arrangement between the assessee and its AE and the observations of the Assessing Officer and the CIT(A) that assessee may pass on profit in the form of dividend is not correct and placed a statement showing analysis of financials from assessment years 2003-04 to 2008-09, which reads as under-
Statement showing analysis of financials from FY 2003-04 to 2007-08
